Why The Minimum Wage Creates Jobs

When Seattle became the first major city in the country to enact a $15/hour minimum wage back in 2014, mainstream economists and the business community predicted that it would end up hurting those low-wage workers it was meant to help. The cost of living would increase dramatically, as businesses increase prices in order to absorb their rising labor costs. Jobs and working hours in the service industry would be cut, leaving thousands of workers unemployed.

Five years have passed since then, and we now have a lot of data on the impact that the new minimum wage has had for Seattle workers. The evidence is clear: the wage hike has overwhelmingly benefited workers in Seattle, and the city’s economy as a whole. Employment in the food service sector has steadily increased since 2010, with no discernible slowdown due to the minimum wage increase, even though restaurants tend to have some of the highest labor costs of any industry.

The wage hike seems to have had little to no impact on the cost of living in Seattle, with consumer prices going up an average of 2.3% from 2014 to 2017, compared to 1.9% from 2011 to 2014. This could easily be statistical noise, but even if it isn’t, low-wage workers’ 50% wage hike (going from $9.57 before the increase to $15 today) more than makes up for the rising cost of living.

Seattle isn’t the only city that has increased its minimum wage in recent years, and the data from those municipalities tell the same story. But have you ever wondered why minimum wages don’t lead to unemployment and major price increases? This is the question I’d like to answer.

The argument against the minimum wage

The basic argument that mainstream economists make against the minimum wage is quite simple; it’s based on a naive supply-and-demand model of the labor market. These economists argue that when the price of any commodity goes up, the demand for that commodity will go down. Since labor is a commodity under capitalism, it is assumed that firms will demand less labor if the price of labor (the wage) is propped up to an artificially high level. You may remember these supply and demand diagrams if you ever took an introductory economics class in high school:

The market wage is plotted on the vertical axis, and the number of jobs offered is plotted on the horizontal axis. Demand for labor is assumed to be “downward-sloping” because less labor is demanded as the wage increases. It’s argued that a minimum wage reduces demand for labor without reducing its supply, leading to unemployment.

The Keynesian critique

The flaw in this point of view was exposed by the British economist John Maynard Keynes in the 1930’s. The thirties were a time of mass unemployment, and mainstream economists were using the exact same supply-and-demand model of the labor market to argue that mass unemployment was a result of wages being too high. Workers were simply too prideful to accept lower wages in the midst of the Great Depression, and they were getting in the way of the market automatically self-adjusting to return to full employment.

But Keynes pointed out that there is a kind of feedback loop between workers’ wages and employment. Businesses will only employ more workers if they need to boost production in response to increasing demand. But most demand comes from workers’ wages— if wages fall, demand will also fall, causing businesses to lay off even more workers, in a downward spiral. On the other hand, if wages rise, demand will rise, causing businesses to hire more workers. This is a fundamental instability in capitalism. Once the economy starts going downhill, market forces will tend to make the downturn even worse. Government intervention is needed to prop up demand during recessions and get the economy out of slumps.

Effects of the minimum wage

If we apply this Keynesian reasoning to the minimum wage, we will find that a minimum wage increase should increase consumer demand, and thereby create jobs, rather than destroying them. Of course, there are limits to this. If the minimum wage were increased to some very high level, say $100/hour, prices would have to increase dramatically in order to keep up with costs and the chaos and uncertainty involved would likely cause a recession.

Additionally, if a state with a lot of manufacturing jobs tries to boost its wages much higher than surrounding states, companies will likely start to move those jobs to lower-wage states. Service jobs are very unlikely to leave an area in response to wage increases, because they basically have to locate themselves wherever the customers are. The same is not true of manufacturing or tech companies, which is why it’s important for the federal government to implement strong labor protections and to pursue a trade policy that protects American workers from the global “race to the bottom.”

It is sometimes argued that higher minimum wages encourage the automation of low-wage jobs, because they make hiring human workers more expensive relative to robots. Over the long run, there is actually some truth to this— but this is a good thing. Here’s why. First of all, technological progress will eventually lead to the automation of most low-wage jobs anyway, so higher minimum wages simply speed up an inevitable process. Furthermore, in the context of high consumer demand created by a minimum wage hike, workers laid off by automation are likely to find other, better jobs relatively quickly. Besides, the Left should want to speed up the automation low-wage jobs. These are mundane, boring jobs that most people don’t want. They key thing is to use government policy to ensure that those who lose their jobs due to automation are able to find better, higher paying, more fulfilling jobs quickly. Free college and job training programs, along with aggressive stimulus programs to keep the economy running at full employment, can ensure that all workers benefit from automation.

American workers deserve a raise

To sum up, minimum wage increases have four positive effects:

Low-wage workers’ incomes increase, lifting many households out of poverty;

New jobs are created, due to increasing consumer demand;

Pressures to automate increase, eliminating the most menial jobs over time;

Inequality is reduced, as income is redistributed from profits to wages.

Labor force participation rate, 2008-2018

American workers could certainly use a substantial minimum wage increase. Income inequality is high, and the labor force participation rate, which measures the proportion of working-age adults who are either working or looking for work, has never recovered from the Great Recession. This means that there are millions of Americans out there who would like to work, but have given up the job search. Increasing the federal minimum wage to $15/hour would reduce income inequality, and would help to employ discouraged workers by stimulating the creation of new living wage jobs. Pegging the minimum wage to the cost of living and productivity gains would also help to ensure that workers share in economic growth going forward.

The next time an Econ 101 student tries to tell you that the minimum wage kills jobs, you can tell them that they simply don’t understand how the economy works.